3 Reasons iRobot Corporation's Stock Could Fall

Shares of iRobot (NASDAQ: IRBT) took a beating after the company released its second-quarter 2014 results in July. The robot maker fell short of revenue estimates, and it missed earnings estimates by a hair if we exclude the benefit of a one-time tax valuation allowance. The stock is down 17% since earnings.

In this piece, we're going to look at three reasons iRobot's stock price couldfall further. To be clear, this is nota declaration that it will fall. We're simply examining one bear thesis, just as we'll also look at a bull argument.

1. Competition among existing players could further heat up

iRobot is the leader in the consumer robotic cleaning space. In addition to its flagship Roomba vacuuming robots, the company also makes floor scrubbing and mopping, gutter cleaning, and pool cleaning bots. However, the Roomba is iRobot's main product, so we'll focus on the robotic vac category.

Competition has been heating up in this space and is likely to continue to do so. iRobot is considered the leader in the more intuitive, higher-end product space. However, LGElectronics and Samsung -- both of which have solid chops in the consumer electronics and related products category -- also compete in this arena. Additionally, there are a good number of manufacturers that offer less intuitive and lower priced products.

When competition heats up, there's almost always pressure on companies to cut prices to maintain or grow market share. Thus far, iRobot's been in decent shape here. However, investors need to keep an eye on iRobot's gross margins, as slips in gross margins can be a telltale sign that a company is experiencing an increasingly competitive landscape.

2. Dyson could enter the robotic vac market

It appears that British vacuuming giant Dyson, led by prolific inventor James Dyson, could be on the verge of entering the robotic vacuuming market. It's been known for some time that Dyson has been spending billions on robotics, and speculation has been that the company has been working on a robotic vacuum. Just last week, Dyson released a video teaser -- see below -- for a big announcement on Sept. 4 that's suggestive of a robotic vacuum.

This is a potentially huge competitive threat. Not only does Dyson have considerable experience in the higher-end vacuuming market, but the company is also good-sized (it generated nearly $10 billion in revenue in 2013 vs. iRobot's $487 million), and its founder has some megadeep pockets.

For background, James Dyson founded his company, which also sells products other than vacuums, after he invented the first bagless vacuum cleaner. Dyson's picture could appear next to the dictionary entries for "tenacious" and "perfectionist." He spent years designing thousands of prototypes of his first vacuum, which was revolutionary as it operates using cyclonic action. Existing manufacturers weren't interested in his vacuum because it didn't need bags, which were a lucrative business for them. So it took him considerable time to bring the product to market. Once the high-end vacuum hit the market, however, it became -- and remains -- very popular.

Given this background, it seems reasonable to believe two things:

Dyson's robotic vacuum, if or when it's launched, will function very well.

Consumers who are happy with Dyson's more conventional vacuums will be predisposed to buy one of its robotic ones.

This scenario is worrisome for iRobot. That said, there is also a potential positive. Dyson's entrance will probably expand consumer awareness of the category and could benefit iRobot, too. I say "could" because we need to wait to see if Dyson's product overlaps price-wise with iRobot's Roomba. If it's considerably pricier, it seems iRobot could benefit. However, if it's in the same price range and functions better, iRobot could be in trouble.

3. Operating cash flow could continue to be pressured

iRobot reported operating income of $17.7 million in the first half of 2014, whereas it had a negative operating cash flow of $7.8 million. In other words, it showed an operating profit from an accounting standpoint, whereas it lost money from a cash basis. A major culprit was accrued compensation. At the least, we'd like the two numbers to be in the same general ballpark.

Two quarters is a relatively short period, and cash flow will vary for numerous good reasons. That said, this divergence between operating income and cash generated from operations could be cause for concern if it persists.

CFO Alison Dean stated during the second-quarter conference call that the company fully expected to make this cash flow deficit up by the second half of the year and achieve its operating cash flow goal, which is a high-single-digit percent of revenue.

While there's currently no reason to doubt Dean's statement, the proof will be on the full-year 2014 cash flow statement. If, for whatever reason, iRobot is still cash flow negative by year's end, it's almost a sure thing that its stock price will fall, regardless of what its books show.

Foolish final thoughts

The threat presented by Dyson's potentially entering the robotic vacuum market is the most worrisome of the three scenarios here. iRobot's home (consumer) business accounts for the lion's share of its revenue (about 90%), and an even greater percentage of its profits, since the segment boasts a higher gross margin than the company's struggling defense and security business. Further, the Roomba vacuuming bot is the company's main product in its home business. There's little doubt that Dyson's launch of a robotic vacuum would surely cause iRobot's stock price to tumble.

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